Stable Dividend Stocks Or Volatile Growth Stocks

Foreword from ShareInvestor

This article “Stable Dividend Stocks or Volatile Growth Stocks” by Jason Lee was first published in the Oct 2009 – Nov 2009 Issue of INVEST magazine and is reproduced in this blog in its entirety. With the sovereign debt crisis in Europe showing little signs of abating and lacklustre global economic data warning of anemic global economic growth sending volatile sessions across stock markets, read on to hear from market watchers on their takes on dividend plays and growth stocks for the individual investor under such investment climate.

Growth stocks are likely to excite investors with share price appreciation – possibly spectacular rises within days. But would dividend plays be a better (and smarter) bet amid the current market volatility? INVEST speaks to market watchers to find out more about both categories of stocks.

Despite market uncertainties over the past one year, Singapore shares have rallied strongly since March: The benchmark Straits Times Index (STI) closed at 2,650.48 points on September 9, an 82 per cent rise from its March 9 low of 1456.95 points. While some observers have urged investors who missed the boat to wait for a correction before entering the market, there are others who expect stock markets around the world, including Singapore’s, to continue the strong rally amid optimism the global economic slump is coming to an end. Besides the ideal timing for making an entry into the market, another key consideration for investors has to be the nature of the stocks they should place their bets on. INVEST speaks to industry watchers on two of the most popular options – dividend plays and growth stocks.

Dividend Plays Versus Growth Stocks

Dividend plays are stocks which provide stable recurring income for the shareholders in the form of regular dividends and are ideal for investors who prefer relatively lower risk in their equity portfolio, says Mr Ang Kay Tiong, Chief Executive Officer of corporate finance firm Stirling Coleman.

The share prices of such dividend stocks also tend to be less volatile as their earnings are rather constant regardless of the economic cycles, says Mr Wilson Liew, Investment Analyst at Kim Eng Research Pte Ltd.

On the other hand, those who seek capital appreciation are likely to opt for growth stocks which typically reinvest bulk of their profits in their business so as to create higher shareholder value. “Growth stocks tend to be priced on the basis of potential increase in earnings, hence there is an element of higher risk as the potential may not be realized. But when (the potential is realized), there is usually greater upside for capital appreciation; for instance, higher returns from share price appreciation,” Mr Liew notes.

Wealth Preservation Versus Wealth Creation

Would it then seem logical to deduce that dividend plays are ideal for those who prefer wealth preservation while those looking for wealth creation should opt for growth stocks?  Several observers think so.

“That is generally the case, as dividend stocks tend to be in defensive sectors which have stable earnings from which they can pay dividends (on a more consistent basis),” Mr Liew explains. “On the other hand, a company with growing earnings should create value for the shareholders by enhancing shareholders’ equity. Rather than paying out a substantial portion of their earnings via dividends, the earnings are re-invested in hope of generating higher returns for the shareholders,” he adds.

“Markets by and large expect growth stocks to be in industries where there are high barriers to entry because of the high technology expertise or intellectual property required, or because they are capital intensive,” says Mr Robson Lee, Partner at Shook Lin & Bok LLP. “Growth stock companies would normally plough their profits back to the business to sustain the business development momentum to enable the envisaged business growth to stay on course. This would mean that there is little or no dividend distribution over a period of time for growth stock companies.”

Enjoying Dividend Payouts And Share Price Appreciation

Since it is logical to assume that most high growth companies prefer to preserve their capital for expansions, the question naturally arises as to whether an investor could possibly enjoy both capital appreciation and dividend payouts from one particular stock?

Typically, the two attributes are quite mutually exclusive, says Mr Liew. “One exception I can think of is REITs (Real Estate Investment Trusts), whereby regular distributions have to be made, but in some instances depending on the market cycle and access to capital, there could be growth opportunities via yield-accretive acquisitions,” he adds.

Another observer however reckons that there are several companies which enhance shareholders’ value through both capital appreciation and dividend payouts. “In the short to medium term, investors in a growth stock may expect capital appreciation rather than dividend payout. However, in the long run, investors will also expect higher dividend payout once the growth stock achieves its business objectives,” says Mr Ang. “There are many blue chip companies that pay good dividends and yet, are able to grow their earnings by double-digit figures annually,” he adds.

Factors To Consider Before Investing

The next question then arises: What are the factors an investor – especially for someone who has limited capital and is unable to maintain a balanced portfolio – should consider before deciding on whether to invest in growth stocks or dividend plays? One key consideration is the risk appetite of the investor, say observers.

“Growth stocks are frequently associated with companies which have yet to achieve a sustainable business model and substantive earnings track record. In a sense, such companies are considered higher-risk investments because of the uncertainties associated with their business prospects and unpredictability in future income streams,” Mr Lee notes. “Risk-adverse investors may eschew growth stocks, or maintain a smaller portfolio of such stocks. Conversely, they are likely to maintain more dividend stocks in their portfolios for the envisaged income returns.”

Concurring, Mr Liew adds: “Due to the perception that dividend stocks tend to be more defensive, risk-averse investors would prefer them to growth stocks. Based on the mantra of ‘high risks, high returns’, risk-savvy investors will take calculated risks (on growth stocks) in order to capture the higher potential capital gain… Whether to overweight on defensive or growth stocks would best be a function of the investor’s ability and willingness to take risks.”

Noting that “speculators frequently buy on hope, hold in greed and sell in fear”, Mr Lee warns that it would be unwise to engage in heavy short-term trading or even ‘shorting’ a stock hoping to profiteer from an envisaged future turn in the share price. “An unexpected ‘change of economic weather conditions’ may lead to a dangerous ‘flash flood situation’ for speculators who are exposed,” he cautions.

What is also crucial is to make an investment decision based on the fundamentals, other observers say. Mr Ang, who stresses the importance of differentiating investments in growth stocks from betting on speculative stocks, says: “Whether it is a dividend play or a growth stock, the company should “have a sound and sustainable business coupled with good management, and good growth prospects”.